Design Capital (HKG:1545) Will Be Hoping To Turn Its Returns On Capital Around

What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Design Capital (HKG:1545) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Design Capital:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.13 = S$8.6m ÷ (S$104m - S$38m) (Based on the trailing twelve months to June 2021).

So, Design Capital has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Trade Distributors industry average of 4.9% it's much better.

Check out our latest analysis for Design Capital

Historical performance is a great place to start when researching a stock so above you can see the gauge for Design Capital's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Design Capital, check out these free graphs here.

What Does the ROCE Trend For Design Capital Tell Us?

In terms of Design Capital's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 31% over the last four years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Design Capital has done well to pay down its current liabilities to 36% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

We're a bit apprehensive about Design Capital because despite more capital being deployed in the business, returns on that capital and sales have both fallen. However the stock has delivered a 19% return to shareholders over the last year, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a separate note, we've found 2 warning signs for Design Capital you'll probably want to know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.